Estate of James A. Elkins, Jr., et al. v. Commissioner, 140 T.C. No. 5 (2013) involved the valuation for estate tax purposes of 64 fractional interests in art, with Mr. Elkins’ children owning the other interests. The art was subject to a co-tenancy agreement and lease and the estate’s appraiser applied a 44.75% discount.
Judge Halpern ignored the co-tenancy and lease agreement under §2703 and held that a 10% discount was appropriate. The co-tenancy agreement provided:
1. Beginning on the date of this Agreement, each Cotenant shall have the right of possession, dominion, and control of each item of the Property for a total number of days out [of] a twelve month period that is equal to his or her percentage interest in such item times the number of days in such twelve month period. During a short calendar year, the number of days to which a Cotenant is entitled to possession, dominion and control of each item of the Property shall be prorated.
2. Each Cotenant, with respect to the exercise of his or her right of possession, dominion, and control, shall request possession of an item of the Property by giving 30 days’ written notice of such request to the Cotenant in possession of such item. The notice shall specify the number of days to which such Cotenant is entitled to possession and the number of days remaining thereof during the twelve month period (or a fewer number of months for a short calendar year). In the event of a conflict among the Cotenants at any time as to which Cotenant is entitled to possession of an item of the Property, Cotenant James A. Elkins, Jr. shall determine which Cotenant is entitled to possession and the number of days remaining thereof.
3. The Cotenant requesting possession (the “Receiving Cotenant”) of an item of the Property shall be responsible for arranging and paying for the transport of such item to the Receiving Cotenant’s residence.
* * * * * * *
6. Each Cotenant shall be responsible, to the extent of his or her percentage interest in the Property, for the cost of maintaining and restoring the Property.
7. An item of the Property may only be sold with the unanimous consent of all of the Cotenants. Any net proceeds from the sale of such item shall be payable to the Cotenants in accordance with their respective percentage interests in the Property.
8. This Agreement shall be binding on Cotenants and on their respective heirs, personal representatives, successors and assigns.
9. This Agreement shall be governed and construed under the laws of the State of Texas.
With respect to the §2703 issue the opinion states:
During trial, we queried Mr. Miller, petitioners’ expert on partition, about paragraph 7 of the cotenants’ agreement. We pointed out to him that, for a sale of any of the jointly owned properties (i.e., works of art) to occur, all of the cotenants would have to agree, and that would be so independent of the language of paragraph 7 of the cotenants’ agreement. He agreed. We added: “So that the statement that an item of property may only be sold with the unanimous consent of all of the cotenants is a rather unremarkable statement of the obvious.” He responded: “I do agree.” With respect to what the language of paragraph 7 accomplished, he testified: “If this language was not in the co-tenancy agreement, any individual interest owner would have the right to commence a partition action.” That is in accord with his direct, written testimony, wherein he states that the right to partition is absolute, although cotenants may expressly or impliedly agree not to partition, and that he has “assumed that Provision 7 * * * is, in essence, an agreement by the Co-Owners not to partition.” With exceptions not here relevant, section 2703(a)(2) instructs that “the value of any property shall be determined without regard to * * * any restriction on the right to sell or use such property.” Whether paragraph 7 of the cotenants’ agreement is a restriction on decedent’s right to sell the cotenant art or is a restriction on his right to use the cotenant art is not important. It is clear that, pursuant to paragraph 7 of the cotenants’ agreement, decedent, in effect, waived his right to institute a partition action, and, in so doing, he relinquished an important use of his fractional interests in the cotenant art. While, as we shall explain, it makes little or no difference to our conclusion as to the value of the art, we shall, in determining the value of each of the items of cotenant art, disregard any restriction on decedent’s right to partition.
The decedent’s children argued that large discounts were appropriate because they would fight any sale; the court turned that on its head and concluded the children’s desire to keep the art meant they would “pay up” and not at a discounted price. Some might argue that the court came close to ignoring, if it did not actually ignore the hypothetical willing buyer-willing seller test, in favor of assuming particular parties to a transaction. The opinion states:
The actual bargaining position that a hypothetical buyer of decedent’s interests in the art would have vis-a-vis the interests of the Elkins children constitutes one of the “relevant facts” that we must deem to be considered by a hypothetical buyer and seller pursuant to section 20.2031-1(b), Estate Tax Regs. See Estate of Winkler v. Commissioner, T.C. Memo. 1989-231, where, in valuing a 10% block of voting stock in a closely held corporation, we took into account the fact that the hypothetical buyer thereof would represent the “swing vote” between the two families that owned the other 90% (50% and 40%) of the voting stock. On that basis, we held that a buyer, unrelated to either family, “would be willing to pay a premium for a 10 percent block of voting stock that could be pivotal as between the two families” and that “a minority discount would be inappropriate here.” See also Estate of Andrews v. Commissioner, 79 T.C. 938, 956 (1982) (“Certainly, the hypothetical sale should not be constructed in a vacuum isolated from the actual facts that affect the value of the stock in the hands of the decedent[.]”); True v. United States, 547 F. Supp. 201, 203 (D. Wyo. 1982) (“Hypothetical analysis can be a valuable tool; however, when real considerations exist, those realities should not and cannot be ignored.”).
The logic of assuming that the Elkins children would pay a hypothetical buyer of decedent’s interests in the art more than a disinterested collector or speculator would have paid for those interests is also confirmed by cases recognizing that certain properties possess an enhanced “assemblage” value. See, e.g., Pittsburgh Terminal Corp. v. Commissioner, 60 T.C. 80, 90 (1973) (dicta: “[W]e do not quarrel with * * * [the taxpayer’s] assertion that aggregation increases the value of coal lands[.]”), aff’d without published opinion, 500 F.2d 1400 (3d Cir. 1974); Serdar v. Commissioner, T.C. Memo. 1986-504.20 In Serdar, the taxpayer gave two parcels of real property to Smith in exchange for a single parcel valued at more than what the Commissioner considered to be the combined value of the taxpayer’s two properties. The Commissioner determined that the difference constituted ordinary income to the taxpayer attributable to a prepayment penalty, owed by Smith to the taxpayer, related to a prior transaction. In rejecting the Commissioner’s argument, we reasoned as follows:
We think that * * * [the Commissioner’s] appraisal failed to adequately take into account factors that made the properties peculiarly adaptable to Smith’s use, and that their fair market value equaled the value of the consideration received for them. The factors that the appraisal failed to adequately take into account are the value to Smith of the road and railroad access that the properties provided and their assemblage value, and, with respect to the Wadsworth Property, the value to Smith of eliminating a tract of land that would have jutted north into his assemblage.
* * * * * * *
In sum, we believe that Smith was convinced that it was essential to acquire * * * [the two properties] to enable him to develop his property as he planned, that he was therefore willing to pay a high price for those properties, and that * * * [the taxpayer] knew of Smith’s plans and drove a hard bargain.
In this case, the hypothetical willing buyer (whether he be a collector or a speculator) and seller of decedent’s fractional interests in the art would know of the Elkins children’s strong desire to own the art in whole. Therefore, the buyer and seller would recognize the former’s ability to drive “a hard bargain” in negotiating a resale of that art to the children.21
Moreover, the hypothetical buyer-collector might very well be content to possess the art for 73.055% (or 50%) of each year. In his written report, Mr. Nash states:
It is not uncommon for two museums, acting together, to buy a work of art. * * * They each take turns in exhibiting the works in proportion to their interests. This would not work in this circumstance because the other owners would be the Elkins Children, and not another museum or institution. Consequently, museums would not be interested in purchasing the interest.
Mr. Nash offers no reason for his conclusion that a museum would not be as willing to share ownership with the Elkins children as it would with another museum or institution, nor do we see one. Moreover, we see no basis for concluding that only a museum jointly owning art with another museum would be content to retain its fractional interest and shared right of possession with another joint owner for an indefinite period. The point, of course, is that a hypothetical buyer-collector, in no rush to sell his or her acquired interests in the art, would be in an even stronger bargaining position than a speculator or art dealer in negotiating a purchase price with the Elkins children.
In short, we find petitioners’ experts’ analyses and conclusions to be unreliable because they are based, in large part, on the false or at least highly dubious assumption that the Elkins children would mount an unrelenting defense of the status quo, ignoring the very high probability that, instead, the children would seek to purchase the hypothetical buyer’s interests in the art. Because we reject that assumption, we find Mr. Mitchell’s discounted values for the art to be unrealistically low.
Looking at all this, the Court arrived at a 10% discount without discussion. Interestingly, in Stone v. United States, 2007 U.S. Dist. Lexis 58611 (N.D.Cal.) (affirmed by the 9th Circuit in an unpublished opinion), the court allowed a 5% discount for fractional interests in art. Experts note that fractional interests in art never, or very rarely, trade at a discount between dealers or museums. Rev. Rul. 58-455 holds that no discount need be taken when a fractional interest is given to charity and Rev. Rul. 57-293 holds the same for remainder interests.